From interest rates to trucking costs, the signs show it’s coming, but it’s unlikely to “gallop away with the economy.”
The inflation that the Federal Reserve has been expecting will arrive soon, but it’s not likely to gallop away with the economy, says PGIM’s leadership.
The Fed has been hiking interest rates for more than two years with the belief that it will rise, and, at its January meeting, set the stage for another increase this month.
“You’ve clearly got really strong growth,” Michael Lillard, head of PGIM Fixed Income, said at a recent panel discussion in New York. “We think that’s going to continue to put pressure on the unemployment rate, pulling it lower. That will cause in our mind inflation to firm a little bit.’’
“We have forces that keep inflation really low. There is globalization and technology changes that we think are going to keep inflation low over the long run.”
Some sectors are already feeling the shift, said Allen Weaver, head of Prudential Capital Group.
“What we see from a company perspective is strong signs that inflation has taken hold, and we will see some impact in prices,” Weaver said. “Labor rates are up, and I think the inflation which we’ve been thinking was going to be taking hold for the last two years is definitely taking hold on the company level.”
Weaver points to the distribution sector as an example. Trucking rates have risen dramatically, partly because of a shortage of drivers and trucks that has been exacerbated by hurricanes Harvey and Irma, he said. Whether these businesses will be able to pass on those price increases will affect their profitability. Another sign of inflation is a tightening labor market. Weaver told the story of how one of Prudential Capital Group’s customers is having difficulty finding warehouse labor and workers that are predictable.
“That’s a crossover of inflation and generational change,” he said. “You’ve got a lot of younger people who say, ‘It’s a gorgeous day, I’m going to the beach.’ So, all of a sudden, the warehouse has a shift it can’t fill. With labor markets tight, people feel, ‘Well, I can find another job if I need to.’”
“What we see from a company perspective is strong signs that inflation has taken hold, and we will see some impact in prices.”
Some employers have been addressing it by taking a cue from the work-on-demand model in the gig economy, where companies post available shifts and employees pick them, he said.
“Think of an Uber construct for manufacturing or warehouse workers,” Weaver said. “Businesses feel that’s going to take hold as younger people are joining the workforce, and they want more control over their shifts.”
Inflation coming from a strong economy would also buoy the real estate market, according to Eric Adler, CEO of PGIM Real Estate.
“If it’s really coming from true growth, that’s going to be good for rents,” Adler said. “A lot of rents are indexed, and people generally pile in to real estate as a good inflation hedge, so we are not concerned about it.”
Even though inflation leads to interest rate increases, which softens capital values, the increased cash flow from rent increases would offset it, assuming the increases are measured, Adler said.
The wrong kind of inflation could be disastrous, however, he added.
“If you start having a sharp spike in these rate increases to combat the kind of inflation that is a depreciation in a way, then all bets are off.”
“If you start having a sharp spike in these rate increases to combat the kind of inflation that is a depreciation in a way, then all bets are off,” Adler said, “and I think real estate is in for a very rough ride.”
Lillard believes that’s not likely to happen, though.
He expects the Fed to be “pretty aggressive” by raising interest rates three or four times this year and two or three times next year, but he doesn’t see runaway inflation because of moderating factors in the global economy.
“We have forces that keep inflation really low,” Lillard said. “There is globalization and technology changes that we think are going to keep inflation low over the long run.”